4/15/2002 @ 12:00AM

Crying wolf

Nvidia, a graphics chipmaker, wants to spice up your PC-but without bowing to Intel. Guess which one will prevail.

For a guy staring down the barrel of a very big gun, Jen-Hsun Huang, the CEO of Nvidia, seems awfully confident. “Nvidia has transcended being the most important 3-D graphics company in the world,” he says. “We are now on our way to becoming one of the most important electronics companies in the world.”

Never mind that Nvidia is enmeshed in two tangles with the U.S. Securities & Exchange Commission (SEC). From August to November the SEC filed insider-trading charges against 12 of its employees, charging that they bought company stock and options after learning that Nvidia had won a contract for Microsoft’s new Xbox game console. Two settled civil charges, one was found liable and three pleaded guilty to criminal charges. In January the SEC raised questions about Nvidia’s costs and reserves in certain quarters; that inquiry is pending.

And never mind that Huang is about to bet a big part of Nvidia’s future on a hotshot new chipset, the Nforce–without being able to sell it to makers of the latest Intel-based PCs that by next year may have 80% of the entire market. Huang, bolstered by a grim resolve to maintain the company’s 38% gross profit margins, balked at paying Intel for a license to let the Nforce work with the Pentium 4 microprocessor. He felt that Intel was demanding too much; such license fees run an estimated $5 on each $20 chipset. Nvidia’s rivals ATI Technologies, Acer Laboratories and others paid up and could outrace Nvidia in next-generation PC graphics.

Not to worry: Huang, who owns a 6% stake in Nvidia worth more than $500 million, is betting that the technology inside Nforce will persuade Intel to cave and push Nvidia beyond the PC and into videogames, cell phones and TV set-top boxes. And Nforce does indeed buttress a PC’s microprocessor to let it churn out stunning animation and rich surround-sound audio that were previously unachievable on the cheap.

Huang is just brash enough to think that he can win against Intel. It is more of a long shot than investors realize: Nvidia has a $6.7 billion market cap, roughly five times sales, and its stock trades at a price-to-earnings ratio of 45. Intel is expected to bring out its own chipset, the 845G, in the second quarter. VIA and ATI offer feature-packed chipsets for as little as half the price of the $40 Nforce.

But Nforce has its fans. Microsoft buys a version of it for Xbox and is expected to use 6 million chipsets a year.

Because of AMD’s Athlon, which doesn’t require a license, Nvidia’s new chipset is in Compaq and Micron PCs. Nvidia, of Santa Clara, California, has since cut deals to supply Nforce for F-22 fighter jets and Exertris exercise bikes. Nforce is Nvidia’s most important new product and should provide 30% of its $2.4 billion in expected sales for fiscal 2003, including Xbox chips, and the bulk of its revenue in five years. More important, given the sluggish PC market for Nvidia’s older lines, Nforce must thrive to keep the company growing at current rates. It earned $177 million on $1.4 billion in revenue in fiscal 2002, most of it coming from graphics chips, such as its GeForce, which wholesales for about $20.

Huang, a chip designer at AMD and lsi Logic, cofounded the company in 1993 with $20 million from Sequoia Capital and others. After two ambitious products that bombed, Huang switched his focus to high-end graphics chips for PCs. He says that his chips, by assuming arduous visual-rendering tasks, do more to boost PC performance than a faster microprocessor can.

The new Nforce moves graphics processing into the chipset, an essential building block that links the microprocessor and the rest of the system.

Huang started work on Nforce with AMD in early 2000. Its graphics chips were already hot sellers. The stock hit $100 in 2000 ($25 adjusted for two stock splits). While Nforce was in the lab, Huang dealt with Microsoft on the Xbox. “They came to us with many deals that didn’t make sense. It was just very draconian,” he says. He hung in and got about $55 apiece for Xbox chipsets, far more than the $30 Microsoft pays for Intel’s Pentium III to run the Xbox.

That bravado hasn’t worked on Intel. “The royalty they are charging others was too rich for our blood,” Huang says. He hopes to strike a deal but insists that Intel respect the intellectual-property value of Nforce. “I know that one of these days they’re going to see that they ought not to be afraid of us,” he says. Intel, afraid? It’s a fantasy worthy of a videogame.